US Airways: Why We Don't Bother Hedging Jet-Fuel Prices

With oil prices continuing to rise, airlines are all getting nervous about it means for the bottom line. Most airlines are stocking up on hedges, but one airline, US Airways (LCC), wants nothing to do with them. Weirdly, the strategy seems to be working quite well so far.

In its fourth quarter 2010 earnings call a couple weeks ago, US Airways detailed that even thought it hadn't bought any fuel hedges, it still had the lowest fuel price per gallon -- $2.40 -- of all its competitors. How is this possible?

I'll let US Airways CFO Derek Kerr explain:

[W]hile we continue to look at the market and think about it, it's hard to rationalize hedging when the cost of the insurance is so incredibly expensive and with the cost of the insurance, last year would have cost us... something like 160 million, if we had an industry average hedging program... despite the fact that fuel [costs] were up from $70 to $92 a barrel across the year. So hard to understand how you can make it systematic hedging program work.

There are a lot of different ways to hedge fuel, but the basic idea is that you pay now to lock in a certain price range for your future fuel needs. If the price of fuel goes up, then you reap the benefits. If the price goes down, you're out the cost of the hedge. The reason for hedging is obvious: you can better budget for your fuel costs (or at least a portion of them) because the amount you'll pay is known in advance. That's obviously not the case when you ride the roller coaster on the open market.

But the fuel hedging game is a lot different now than it was 10 years ago. Southwest was seen as the genius of the industry when it hedged a huge chunk of its fuel needs in the $25 to $40 range just as prices spiked. It helped the airline make money during a time when others lost, and that set the standard for fuel hedging. But things are different now.

Now that fuel prices appear to be more volatile than in the past, it costs more to hedge. US Airways, for example, said that it would cost $330 million just in hedging costs to secure the fuel it needs for the next year. That's more than 10 percent of the cost of the fuel itself, based on 2010 numbers. So hedging can be steep, and the airline will have to assume that the benefit will be much greater in order for it to make sense.

While other airlines continue to hedge in order to keep costs predictable on some level, US Airways has done the math and decided it's not worth it. So far, it's been right. If oil prices spike to $200 a barrel -- well, that's a different story. And if that happens, this industry might no longer exist anyway.